Shocks, financial constraints and households’ consumption amid the great recession

Abstract

Overall, there is now considerable evidence that financial constraints are at the root of the lack of consumption smoothing during the Great Recession. We push this evidence forward and show that in the presence of credit constraints, a job loss leads to larger drops in households’ consumption. We build a set of testable hypotheses from our theoretical model and employ microdata taken from the second round of the Life in Transition Survey (LiTS II) (European Bank for Reconstruction and Development 2010). We specifically assess the role of financial constraints in explaining households’ consumption coping strategies after the crisis shocks. Economic hardship is more likely to be observed if households experience difficulties in meeting outstanding debt obligations or in obtaining new credit lines because of financial constraints. The impact of job and wage shocks on households’ consumption is much attenuated, by around a half, when we control for sample selection bias in accessing the formal credit markets. In the context of increasing impoverishment across Europe, the paper shows that a careful analysis of the main determinants of households’ economic and financial hardship is crucial to formulate targeted measures at the regional and local level.